Lenders Gain Choice on Accounting for MSRs

The FASB has finally issued Financial Accounting Standard 156, which industry sources are calling a slam-dunk victory for mortgage servicers.

The FASB said that the new standard, an amendment to FAS 140, will simplify the accounting for servicing assets and liabilities such as those created by mortgage securitization. In a nutshell, it makes it easier for lenders to hedge their mortgage servicing rights without jumping through the hoops required to obtain "hedge accounting" under the former rules. The hedge accounting tests, designed to make sure lenders can prove their hedge strategy is effective, are contained in a complicated accounting rule known as FAS 133.

And even better yet, lenders that prefer the old rules can continue to account for servicing rights using the amortization method, which requires them to book servicing rights at the "lower of cost or market" on their balance sheets. While most big lenders will make the switch to fair value accounting, it is anticipated that some smaller lenders might stick with LOCOM to limit volatility in the valuation of their MSRs.

"The board specifically designed this statement to simplify and encourage more consistent accounting in this area," said Edward W. Trott, FASB member, in a news release. "The standard is the latest step in a series of projects aimed at reducing complexity while providing an approach that allows hedge-like accounting without having to deal with the complexities of Statement 133."

Mr. Trott noted that the statement is effective for all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity's fiscal year that begins after Sept. 15, 2006, with early adoption permitted.

Alison Utermohlen, senior director for government affairs at the Mortgage Bankers Association, said that giving lenders a choice about which accounting framework to use was a big victory for the industry.

"By permitting companies to elect to mark-to-market their servicing rights, this new statement effectively means our largest members do not have to go to the time and significant expense of qualifying their servicing hedging activities for hedge accounting under FAS 133," Ms. Utermohlen told MSN.

Under the old rules, lenders that hedged their portfolios with derivatives could be forced to mark their derivative portfolios to market if they failed to pass the tests needed for hedge accounting. But they were limited on the extent to which they could offset derivative losses on paper with gains in the value of their MSR portfolios. That could distort quarterly earnings reports.

In a rising interest rate environment, when the market value of MSRs would be rising and the value of instruments used to hedge the portfolios would be falling, large mortgage bankers "would be walking on eggshells" because of concern about qualifying for hedge accounting treatment under the old rule, she said.